PAGE
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended . . . . . . . . .September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from . . . . . . . . . . . .to
Commission file number: 0-8641
SELECTIVE INSURANCE GROUP, INC.
(Exact name of registrant as specified in its charter)
New Jersey 22-2168890
- -------------------------------- ----------------------------------
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
40 Wantage Avenue, Branchville, New Jersey 07890
------------------------------------------ ------------
(Address of principal executive offices) (Zip Code)
973-948-3000
-------------------------------
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such report), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
Common stock, par value $2 per share, outstanding as of October 31, 1998:
28,236,811
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SELECTIVE INSURANCE GROUP, INC.
-------------------------------
Consolidated Balance Sheets
-------------------------------
(dollars in thousands)
Unaudited Audited
ASSETS September 30 December 31
- ------ 1998 1997
Investments: ------------ ----------
Debt securities, held-to-maturity -
at amortized cost (fair value of
$388,334-1998; $426,251-1997)......... $ 370,557 410,169
Debt securities, available-for-sale -
at fair value (amortized cost of
$1,000,306-1998; $1,009,060-1997)..... 1,050,907 1,044,390
Equity securities, available-for-sale -
at fair value (cost of
$138,216-1998; $120,602-1997)......... 236,355 222,273
Short-term investments
-at cost which approximates fair value 37,415 28,781
Other investments - at fair value.......... 31,023 20,077
--------- ---------
Total investments ...................... 1,726,257 1,725,690
Cash....................................... 9,967 5,017
Interest and dividends due or accrued ..... 21,699 23,474
Premiums and other receivables............. 253,012 196,786
Reinsurance recoverable on paid losses
and loss expenses..................... 10,085 11,088
Reinsurance recoverable on unpaid losses and
loss expenses......................... 134,831 124,197
Prepaid reinsurance premiums............... 30,040 31,189
Deferred Federal income tax................ 486 6,489
Real estate, furniture and equipment....... 49,935 45,465
Deferred policy acquisition costs.......... 115,300 98,110
Goodwill................................... 16,328 17,337
Other assets............................... 42,140 21,349
--------- ---------
Total assets............................ $ 2,410,080 2,306,191
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Liabilities:
- -----------
Reserve for losses......................... $ 1,005,776 984,393
Reserve for loss expenses.................. 179,171 176,776
Unearned premiums.......................... 417,668 373,766
Convertible subordinated debentures........ 6,272 6,845
Short-term debt ........................... 24,780 17,400
Notes payable.............................. 89,714 89,714
Current Federal income tax................. 1,107 1,747
Other liabilities ......................... 104,810 90,234
--------- ---------
Total liabilities....................... 1,829,298 1,740,875
--------- ---------
Stockholders' Equity:
- --------------------
Common stock of $2 par value per share:
Authorized shares-180,000,000
Issued: 36,973,771-1998; 36,363,856-1997... 73,948 72,728
Additional paid-in capital................. 37,822 30,450
Accumulated other comprehensive income-
net unrealized gains on available-for-sale
securities, net of deferred income
tax effect............................ 96,681 89,051
Retained earnings.......................... 469,984 439,811
Treasury stock - at cost
(shares: 8,516,624-1998; 7,097,462-1997) (90,749) (59,785)
Deferred compensation expense and notes
receivable from stock sales........... (6,904) (6,939)
--------- ---------
Total stockholders' equity ............. 580,782 565,316
--------- ---------
Total liabilities and stockholders' equity $ 2,410,080 2,306,191
========= =========
See accompanying notes to unaudited consolidated financial statements.
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SELECTIVE INSURANCE GROUP, INC.
================================
Consolidated Statements of Income
(dollars in thousands, except per share data)
Unaudited Unaudited
Quarter ended Nine Months Ended
September 30 September 30
1998 1997 1998 1997
------ ------ ------ ------
Revenues:
- --------
Net premiums written.................$ 196,447 200,680 581,547 573,126
Net increase in unearned premiums
and prepaid reinsurance premiums (10,059) (30,764) (45,051) (63,374)
------- ------- ------- -------
Net premiums earned ................. 186,388 169,916 536,496 509,752
Net investment income earned......... 23,604 24,479 72,792 73,605
Net realized gains................... (91) 3,386 2,788 5,355
Other income......................... 2,788 1,120 7,123 3,392
------- ------- ------- -------
Total revenues.................... 212,689 198,901 619,199 592,104
------- ------- ------- -------
Expenses:
- --------
Losses incurred ..................... 112,431 98,279 325,824 293,934
Loss expenses incurred............... 20,415 20,094 55,388 59,643
Policy acquisition costs............. 58,797 50,978 169,583 153,686
Dividends to policyholders........... 1,040 1,007 3,740 3,300
Interest expense..................... 2,437 2,454 7,003 7,193
Other expenses....................... 2,139 1,857 5,655 6,237
------- ------- ------- -------
Total expenses.................... 197,259 174,669 567,193 523,993
------- ------- ------- -------
Income before Federal income tax 15,430 24,232 52,006 68,111
------- ------- ------- -------
Federal income tax expense:
Current.............................. 2,459 5,340 7,614 13,000
Deferred............................. 39 497 1,894 2,912
------- ------- ------- -------
Total Federal income tax
expense......................... 2,498 5,837 9,508 15,912
------- ------- ------- -------
Net income...........................$ 12,932 18,395 42,498 52,199
======= ======= ======= =======
Earnings per share:
- ------------------
Basic.............................$ 0.46 0.64 1.48 1.81
Diluted...........................$ 0.43 0.60 1.37 1.71
Dividends to stockholders............$ 0.14 0.14 0.42 0.42
See accompanying notes to unaudited consolidated financial statements.
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SELECTIVE INSURANCE GROUP, INC.
Consolidated Statements of Cash Flows
Unaudited
Nine months ended Sept. 30
(dollars in thousands) 1998 1997
---- ----
Operating Activities
- --------------------
Net income $ 42,498 52,199
Adjustments to reconcile net income to
net cash provided by operating activities:
Decrease in interest and dividends due or accrued 1,775 1,286
Increase in premiums and other receivables (56,226) (57,815)
Decrease (increase) in reinsurance recoverable
on paid losses and loss expenses 1,003 (4,313)
Increase in reserves for losses and loss
expenses,net of reinsurance recoverable on
unpaid losses and loss expenses 13,144 7,966
Increase in unearned premiums, net of
prepaid reinsurance premiums 45,051 63,374
Decrease in net Federal income tax asset 1,254 3,215
Increase in deferred policy acquisition costs (17,190) (19,354)
Depreciation and amortization 6,500 6,245
Net realized gains on investments (2,788) (5,355)
Other - net (3,374) (15,571)
------ ------
Net adjustments (10,851) (20,322)
------ ------
Net cash provided by operating activities 31,647 31,877
------ ------
Investing Activities
- --------------------
Purchase of debt securities, held-to-maturity (12,682) (31,730)
Purchase of debt securities, available-for-sale (116,063) (120,948)
Purchase of equity securities, available-for-sale (32,250) (21,815)
Purchase of other investments (15,451) (9,000)
Sale of debt securities, available-for-sale 59,902 29,057
Redemption and maturities of debt securities,
held-to-maturities 52,264 54,788
Redemption and maturities of debt securities,
available-for-sale 66,454 25,883
Sale of equity securities, available-for-sale 16,387 13,697
Proceeds from other investments 5,316 223
Decreae (increase) in net payable for security
transactions (3,715) 2,891
Net additions to real estate, furniture
and equipment (9,341) (2,311)
------ ------
Net cash provided by (used in)
investing activities $ 10,821 (59,265)
------ ------
See accompanying notes to unaudited consolidated financial statements.
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SELECTIVE INSURANCE GROUP, INC.
Consolidated Statements of Cash Flows, continued
Unaudited
Nine months ended Sept 30
(dollars in thousands) 1998 1997
---- ----
Financing Activities
- --------------------
Dividends to stockholders $ (12,325) (12,313)
Acquisition of treasury stock (30,964) (3,571)
Proceeds from short-term debt 7,380 15,500
Net proceeds from dividend reinvestment plan 859 849
Net proceeds from stock purchase and
compensation plans 7,161 10,243
Increase in deferred compensation expense and
proceeds received on notes receivable from
stock sales (995) (5,964)
------ ------
Net cash (used in) provided by financing
activities (28,884) 4,744
------ ------
Net Increase (decrease) in short-term
investments and cash 13,584 (22,644)
Short-term investments and cash at
beginning of year 33,798 40,022
------ ------
Short-term investments and cash at
end of period $ 47,382 17,378
====== ======
Supplemental disclosures of cash flow information
- -------------------------------------------------
Cash paid during the period for:
Interest $ 7,679 7,256
Federal income tax 8,254 12,697
Supplemental schedule of
non-cash financing activity:
Conversion of convertible subordinated
debentures 573 33
See accompanying notes to unaudited consolidated financial statements.
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Notes to Unaudited Consolidated Financial Statements
- ----------------------------------------------------
1. Basis of Presentation
The interim financial statements are unaudited but reflect all
adjustments which, in the opinion of management, are necessary to provide a
fair statement of the results of the Selective Insurance Group, Inc. and
its consolidated subsidiaries (collectively, the "Company") for the interim
periods presented. References herein to "Selective" are to Selective
Insurance Group, Inc. All such adjustments are of a normal recurring
nature. The results of operations for any interim period are not
necessarily indicative of results for the full year. These financial
statements should be read in conjunction with the financial statements and
notes thereto contained in the Company's Annual Report on Form 10-K for the
year ended December 31, 1997.
2. Adoption of Accounting Policies
During 1998, the Company adopted the following accounting policies:
(a) The American Institute of Certified Public Accountants issued
Statement of Position No. 97-3 "Accounting by Insurance and Other
Enterprises for Insurance related Assessments" ("SOP 97-3"). SOP 97-3
establishes standards for accounting for guaranty-fund and certain other
insurance related assessments. SOP 97-3 is effective for fiscal years
beginning after December 15, 1998 and requires the impact of adoption to be
reported as a change in accounting principle. SOP 97-3 was adopted in 1998
by the Company and had no material effect on the Company's results of
operations or financial condition.
(b) The American Institute of Certified Public Accountants issued
Statement of Position No. 98-1 "Accounting for the Costs of Computer
Software Developed or Obtained for Internal-Use" ("SOP 98-1"). SOP 98-1
provides guidance on accounting for the costs of computer software
developed or obtained for internal-use and when such costs incurred should
and should not be capitalized. SOP 98-1 is effective for all fiscal years
beginning after December 15, 1998. The provisions of SOP 98-1 should be
applied to internal-use software costs incurred in those fiscal years for
all projects, including those projects in progress upon initial application
of the statement. Earlier application is encouraged in fiscal years for
which annual financial statements have not been issued. SOP 98-1 was
adopted by the Company during the first quarter of 1998. As a result of SOP
98-1, the Company capitalized $3 million of computer software development
costs.
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SELECTIVE INSURANCE GROUP, INC.
Notes to Unaudited Consolidated Financial Statements, continued
(C) Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("FASB 130"), was adopted during the first
quarter of 1998. FASB 130 requires the Company to report total
comprehensive income in condensed financial statements of interim
periods.
The following is a presentation of the Company's total comprehensive income
for the periods ended September 30, 1998 and 1997.
Quarter ended Nine months ended
September 30 September 30
-------------- -----------------
(dollars in thousands) 1998 1997 1998 1997
---- ---- ---- ----
Net income $12,932 18,395 42,498 52,199
------- ------ ------ ------
Other comprehensive income:
Unrealized holding gains
(losses) arising
during period (11,178) 27,099 14,527 54,363
Less: reclassification
adjustment for net
realized (gains) losses
included in net income 91 (3,386) (2,788) (5,355)
------- ------ ------ ------
Other comprehensive income
(loss) before tax (11,087) 23,713 11,739 49,008
Income tax benefit (expense)
related to items of other
comprehensive income 3,880 (8,300) (4,109) (17,153)
------- ------ ------ ------
Other comprehensive income
(loss), net of tax (7,207) 15,413 7,630 31,855
------- ------ ------ ------
Total comprehensive income $ 5,725 33,808 50,128 84,054
======= ====== ====== ======
3. Current Accounting Pronouncements
In June of 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No, 133, "Accounting for
Derivative Instruments and Hedging Activities" ("FASB 133"). FASB 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts,
(collectively referred to as derivatives) and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. This statement is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999, earlier application
is encouraged, but it is permitted only as of the beginning of any fiscal
quarter that begins after issuance of this statement. This Statement should
not be applied retroactively to financial statements of prior periods. The
Company does not currently invest in derivative securities, therefore the
adoption of this statement is not expected to have a material effect on the
Company's results of operations or financial condition.
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SELECTIVE INSURANCE GROUP, INC.
Notes to Unaudited Consolidated Financial Statements, continued
4. Reinsurance
The following is a table of assumed and ceded amounts by income statement
caption:
Quarter ended Nine months ended
September 30 September 30
(in thousands) 1998 1997 1998 1997
- --------------------------------------------------------------------------
Net premiums written:
Assumed $ 5,600 7,397 17,644 18,509
Ceded (23,661) (23,280) (58,630) (61,976)
Net premiums earned:
Assumed $ 4,990 6,882 17,623 17,802
Ceded (18,272) (21,292) (59,779) (62,092)
Losses incurred:
Assumed $ 3,778 5,094 14,035 10,738
Ceded(1) (10,126) (12,121) (38,457) (21,849)
Loss expenses incurred:
Assumed $ 425 659 1,620 1,599
Ceded (381) (564) (1,983) (1,434)
(1) During the first nine months of 1998, the increase in ceded losses
incurred resulted from several severe claims ($11 million in reinsurance
recovered) in 1998 and $7 million flood claims. The flood business is ceded
100% to the National Flood Insurance Program and therefore, the Company is a
servicer of this type of insurance and bears no risk of policyholder loss.
5. Reclassifications
Certain amounts in the Company's prior year consolidated financial
statements have been reclassified to conform with the 1998 presentation.
All earnings per share amounts for all periods have been presented and
restated to conform to FASB 128, "Earnings per Share" requirements. Such
reclassification and presentation changes had no effect on the Company's
net income or stockholders' equity.
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Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
---------------------------------------------------------------
This quarterly report on Form 10-Q contains certain statements that are not
historical facts and are considered "forward-looking statements" (as
defined in the Private Securities Litigation Reform Act of 1995), which can
be identified by terms such as "believes," "expects," "intends," "may,"
"will," "should," "anticipates," "benefits," the negatives thereof, or by
discussion of strategy, goals and/or future expectations. Such
forward-looking statements involve opinions and predictions based on current
information and assumptions, and no assurance can be given that the future
results will be achieved since events or results may materially differ as a
result of risks and uncertainties facing the Company. These include, but are
not limited to, economic, market or regulatory conditions, competition, and
investment risks, as well as risks associated with the Company's entry into
new markets, diversification and catastrophic events.
The following discussion relates to the Company's results of operations,
financial condition and liquidity for the interim periods indicated.
References herein to the "Company" are references to Selective Insurance
Group, Inc. and its consolidated subsidiaries, collectively. References
herein to "Selective" are to Selective Insurance Group, Inc.
Results of Operations
- ---------------------
The following discussion is a comparison of Third Quarter Ended
September 30, 1998 ("Third Quarter 1998"), and Nine Months Ended September
30, 1998 ("Nine Months 1998"), to Third Quarter Ended September 30, 1997
("Third Quarter 1997"), and Nine Months Ended September 30, 1997 ("Nine
Months 1997").
During the Third Quarter 1998, certain business classes were reclassified
from the Mercantile and Service and Habitational and Recreational SBUs to
the Community Services and Organizations SBU (formerly the Public Entities
SBU). Prior amounts reported have been reclassified to conform with the
Third Quarter 1998 presentation.
Revenues
Net premiums written for the Nine Months 1998 increased 1%, or $8 million as
compared with the same period in 1997. For the Third Quarter 1998 net
premiums written decreased 2%, or $4 million, compared with the same period
in 1997. Net premiums written for the Third Quarter 1997 and Nine Months
1997 included a one-time benefit of $15 million, and $30 million
respectively, pertaining to renewal business only, due to the conversion of
New Jersey personal automobile policies from a six month term to an annual
term (the "Conversion"), effective April 1, 1997. Excluding the effects of
the Conversion, and a one-time increase of $4 million in the Nine Months
1998, which reflected the Company's modification of the New Jersey
Homeowners Quota Share Reinsurance Program, the Third Quarter 1998 and Nine
Months 1998 net premiums written increased $11 million, or 6% and $34
million, or 6% respectively, when compared with the same periods in 1997.
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The commercial SBUs net premiums written increased $10 million, or 8% and
$38 million, or 10% for the Third Quarter 1998 and Nine Months 1998,
respectively, resulting from increases in all commercial SBUs except for
the Community Services and Organizations SBU. These results reflected an
increase of $9 million and $32 million of net premiums written from new
business written in the commercial SBUs for the Third Quarter 1998 and Nine
Months 1998, respectively, over the corresponding prior year periods. This
growth in net premiums written from new business was primarily due to the
Company's increase in the number of field underwriters (the key contact
between the independent agent and the Company), the Company's Midwestern
expansion and the Company's strengthening of agency relationships. Net
premiums written which were non-renewed due to agency terminations were $7
million and $10 million less during the Third Quarter 1998 and Nine Months
1998 respectively, when compared to the corresponding prior year period.
The increases in net premiums written were partially offset by: 1) a
reduction in existing business resulting primarily from competition; 2)
re-evaluation of certain underwriting risks; and 3) decreasing premium in
the community services and organizations SBU mainly due to the continuing
trend, in this customer segment, towards self-insurance mechanisms and other
alternative markets.
The Personal Lines SBU net premiums written remained relatively flat,
excluding the effect of the Conversion, for both the Third Quarter 1998 and
Nine Months 1998. Net premiums written for the Nine Months 1998 increased
primarily due to a reduction in the amount of premium ceded under the New
Jersey Homeowners Quota Share Reinsurance Program. These changes resulted
in a $2 million increase for the Third Quarter 1998 and $10 million increase
for the Nine Months 1998 in homeowners net premiums written ($4 million of
which was due to a one-time adjustment in the first quarter of 1998
reflecting the return of a portion of the ceded reinsurance unearned premium
reserves from the previous year). In addition, the personal lines SBU has
recently introduced enhanced products in some of the Company's territories
in order to expand its personal insurance segment. This expansion effort
resulted in an increase in net new business written of $3 million for the
Third Quarter 1998 and Nine Months 1998. These increases were offset by
reductions in personal automobile net premiums written of $2 million for
the Third Quarter 1998 and $10 million for the Nine Months 1998 mainly in
New Jersey due to a reduction in existing business resulting primarily from
competition.
The increase in 1998 net premiums written resulted in an increase in net
premiums earned. After an insurance policy is sold, net premiums written
are recorded for the sales transaction and then earned over the life of the
insurance policy (which is generally a one-year term). The growth in the
1998 net premiums written resulted in an increase of 10%, or $16 million,
and 5%, or $27 million, in net premiums earned for the Third Quarter 1998
and Nine Months 1998, respectively when compared with the same periods in
1997.
Net investment income earned for the Third Quarter 1998 and Nine Months
1998 remained essentially flat over the same periods in 1997. Although the
amount of assets generating investment income increased slightly when
compared to September 1997, the additional income earned from the growth in
invested assets was offset by redemptions and maturities of higher yielding
debt securities reinvested at lower fixed income yields currently available
in the marketplace. These factors reduced the Company's overall annualized
investment
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yield as of September 30, 1998 to 5.8%, down from 6.0% for the same period
in 1997. In addition, growth in invested assets has been minimal because
$31 million of the cash from operations was used during the Nine Months
1998 to repurchase approximately 1.4 million shares of Company stock.
Expenses
The ratio of losses and loss expenses incurred to net premiums earned for
the Third Quarter 1998 and Nine Months 1998 was 71.3% and 71.1%,
respectively. These ratios represent a 1.6 point and a 1.7 point
increase over the ratios for the Third Quarter 1997 and Nine Months 1997
periods. Weather-related claims of $4 million (before-tax) and $10 million
(before-tax), respectively increased these ratios by 2.2 points and 1.8
points for the Third Quarter 1998 and Nine Months 1998, respectively.
The weather-related losses primarily impacted the Habitational
& Recreational and Mercantile & Service SBU's. Excluding the effects of the
weather-related claims, the loss and loss expense ratio decreased 0.6 points
for the Third Quarter 1998 and remained flat for the Nine Months 1998,
compared to the same periods in 1997.
Overall, the commercial SBUs' loss and loss expense ratio increased by 4.1
points and 2.8 points for the Third Quarter 1998 and Nine Months 1998,
respectively. These increases reflected weather-related claims which
resulted in increases of 2.7 points for the Third Quarter 1998 and 2.2
points for the Nine Months 1998. Excluding the effects of the 1998
weather-related claims, the commercial SBUs loss and loss expense ratio
increased by 1.4 points for the Third Quarter 1998 and 0.6 points for the
Nine Months 1998. Unfavorable results in both the workers' compensation and
commercial automobile lines of insurance contributed to the overall increase
in most of the commercial SBUs loss and loss expense ratios. The increase
in the loss and loss expense ratio for workers' compensation primarily
resulted from the continuing competitive pricing pressures associated with
this line of insurance throughout all of the commercial SBUs and some state
mandated rate decreases. The adverse results in the commercial automobile
line of insurance were mainly due to several severe claims and a slight
increase in the frequency of claims. In response to the performance of the
commercial automobile business, the Company continues to review this
business, including loss control, re-evaluating risk selection and re-
evaluating risk classification. These increases were partially offset by
improvement in the general liability line of insurance in most of the
commercial SBUs. Much of this improvement resulted from the Company's
initiatives to reduce legal fees incurred in the course of the claim
settlement process.
The Personal Lines SBU loss and loss expense ratio decreased by 4.1 points
and 0.4 points for both the Third Quarter 1998 and Nine Months 1998 to
69.7% and 73.2%, respectively. The decrease in the Third Quarter 1998 ratio
was primarily due to fewer homeowners claims reported compared to the same
period in 1997. In addition, New Jersey personal automobile results
continued to be favorable at a 75.7% and 75.6% loss and loss expense ratio
for the Third Quarter 1998 and Nine Months 1998, respectively.
There is an excess profits law in New Jersey, which sets a maximum profit
level on personal automobile insurance. Under New Jersey regulations, an
insurer's excess profits earned on direct insurance written in New Jersey on
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private passenger automobiles, as determined pursuant to an actuarial
formula set forth in applicable regulations ("NJ Excess Profits"), are
subject to refund or credit to policyholders. A NJ Excess Profits
calculation must be made by an insurer for this purpose and submitted to
the New Jersey Department of Banking and Insurance each year for the
three-year period including the year for which the calculation is done and
the two calendar years immediately preceding such year.
For the three-year period ended December 31, 1997, the Company's most recent
submission indicated that it had no obligation to make an excess profit
premium refund. However, if the Company's current profitability continues
in its New Jersey personal automobile business, it is possible that it will
incur an excess profit premium refund obligation in the future. The Company
considers the potential effect of such excess profits in establishing its
loss reserves.
On May 19, 1998, the Governor of New Jersey signed into law personal
automobile insurance reform legislation. The law contains multiple
implementation dates that will be determined through the adoption of
regulations. One provision of the law reduces average statewide automobile
insurance premiums by 15%, with the greatest reductions being applicable to
liability-only policies. The Company anticipates that this provision will
become effective on or about April 1, 1999, and that its New Jersey personal
automobile direct premiums written will be reduced between 11% and 12%, or
approximately $17 million. This is less than the average of 15% because a
higher proportion of Selective's policies provide physical damage coverage,
on which the rate reduction will be lower.
The law also contains provisions that are intended to reduce loss costs.
These provisions include: (i)revisions to the state's no-fault law; (ii)
increased fraud prosecution initiatives; and (iii) the elimination of
unnecessary medical tests and the use of medical fee schedules. The Company
is currently unable to estimate the extent of such savings, however,
believes the new law will not significantly impact its overall after-tax
financial results due to reductions in policy acquisition costs
(commissions, premium taxes, etc.) from the lower premium volume, and
potentially lower costs as a result of the savings provisions included in
the law. In addition, the reduction in premiums written as a result of the
law should reduce the possibility of a NJ Excess Profits premium refund
obligation after the new law is implemented in 1999.
The ratio of policy acquisition costs to net premiums earned for the Third
Quarter increased from 30.0% to 31.5% in 1998 and from 30.1% to 31.6% for the
Nine Months 1998. The 1.5 point increase in the ratio primarily reflected
an increase in the relationship of commission expenses, state premium tax
expenses and labor costs expressed as a percentage of net premiums earned,
which added approximately 0.9 points, 0.1 points and 0.5 points,
respectively. Commission expenses increased as a percentage of net
premiums earned primarily due to commission incentives to agents to increase
profitable business with the Company which resulted in an increase of
0.7 points and an increase in lines of insurance which pay a higher general
commission rate than personal
-12-
PAGE
lines which resulted in a 0.2 point increase. State premium tax expenses
have increased mainly due to the Company's effort to diversify and write
more business outside of New Jersey. Many states have higher state premium
tax rates than New Jersey. Labor costs have increased in 1998 primarily due
to the Company's staffing increases in its Midwest operation and the hiring
of additional field underwriters. Labor cost increases due to staffing
additions in the Information Technology Operations have been offset by the
capitalization of labor costs associated with the internal development of
new information systems.
Total Federal income tax expense decreased by approximately $4 million, to
$2 million, for the Third Quarter 1998, compared to $6 million for the same
period in 1997. For the Nine Months 1998, the Federal income tax expense
decreased approximately $6 million, to $10 million, compared to $16 million
for the Nine Months in 1997. The Company's effective tax rate was 18.3% for
the Nine Months 1998, compared with 23.4% for the Nine Months of 1997. The
Company's effective tax rate differs from the Federal corporate rate of 35%
primarily as a result of the tax-exempt investment income. The effective
tax rate for the Nine Months 1998 was lower than the Nine Months 1997,
mainly due to the higher level of underwriting losses in 1998.
-13-
PAGE
Income
The table below shows operating income, net realized gains (losses), and net
income, including per share amounts for the Quarter and Nine Months Ended
1998 and 1997.
- ----------------------------------------------------------------------------
Quarter ended Nine months ended
($ in thousands, September September
except for per share data) 1998 1997 1998 1997
- ----------------------------------------------------------------------------
Operating income, excluding
net realized gains
(net of tax) (1) $12,991 16,194 40,686 48,718
Net realized gains (losses),
net of tax (59) 2,201 1,812 3,481
------ ------ ------ ------
Net income (1) 12,932 18,395 42,498 52,199
====== ====== ====== ======
Per diluted Share:
Operating income (1) .43 .53 1.31 1.59
Net realized gains (losses) .00 .07 .06 .12
Net income (1) .43 .60 1.37 1.71
(1)Operating and net income for the Third Quarter and Nine Months 1998,
include weather-related storm losses of $3 million (net of tax), or $.09 per
diluted share, and $6 million (net of tax), or $.20 per diluted share,
respectively.
-14-
PAGE
Financial Condition, Liquidity and Capital Resources
- ----------------------------------------------------
Selective is an insurance holding company whose principal assets are its
investments in its insurance subsidiaries. As an insurance holding company,
Selective meets its cash requirements through proceeds from the sales of the
Company's common stock and dividends from its insurance subsidiaries, the
payments of which are subject to state regulatory requirements.
The overall obligations and cash outflow of the Company include: claim
settlements; commissions; labor costs; premium taxes; general and
administrative expenses; investment purchases; interest expenses; capital
expenditures with respect to the Company's automation program; principal
payments on the senior notes and dividends to policyholders and
stockholders. The insurance subsidiaries satisfy their obligations and cash
outflow through premium collections, interest and dividend income and
maturities of investments.
The Company's cash requirements also include the cost of shares of common
stock repurchased under its common stock repurchase program. On July 2,
1996, the Company's Board of Directors (the "Board") authorized management
to repurchase up to two million shares of Selective's common stock. The
stock may be repurchased from time to time in the open market or in
privately negotiated transactions. The determination to make such purchases
is made based on market conditions, available cash and alternative
investment opportunities. On July 28, 1998, the Board authorized Selective
to repurchase an additional two million shares of its common stock under the
repurchase program. As of September 30, 1998, the Company had repurchased a
total of 2.0 million shares at a total cost of $44 million under the program,
of which 1.4 million shares were repurchased during the Nine Months 1998 at
a total cost of $31 million.
For the Nine Months 1998 and Nine Months 1997, cash provided by operating
activities remained flat at $32 million. The higher levels of net premiums
written during 1998 were offset by an increase in claims paid. The rate at
which outstanding claims are being paid and closed has increased due to the
implementation of claims management specialists ("CMSs") in the field and
improved litigation management. The Company believes that the deployment
of the CMSs and the enhanced litigation management programs will result,
over the long-term, in more favorable claim settlements. However, the
short-term impact of these programs has been an increase in claim payments
of approximately $15 to $20 million, which has reduced cash provided by
operating activities for the Nine Months 1998. The Company anticipates this
trend to continue through the remainder of 1998 and into 1999. The Company
expects to generate cash from operations over the balance of the year.
Total assets increased 5%, or $104 million, from December 31, 1997 to
September 30, 1998. The growth was due to: (i) an increase in premiums and
other receivables of $56 million and deferred policy acquisition costs
(policy acquisition costs which are deferred and amortized over the life of
the policy period) of $17 million primarily due to the increased premium
volume; (ii) a $21 million increase in other assets primarily due to a $16
million investment
-15-
PAGE
by the Company to offset a short sale transaction; (iii) an increase in
reinsurance recoverable on unpaid losses and loss expense of $11 million due
to a few severe claims and an increase in flood claims. The above increases
were partially offset by a $6 million decrease in deferred Federal income
taxes which mainly reflected the associated deferred taxes on increases in
unrealized gains on available-for-sale securities and deferred policy
acquisition costs.
The rise in total liabilities of 5%, or $88 million, from December 31, 1997
to September 30, 1998 was mainly attributable to an increase in unearned
premiums of $44 million and an increase of $24 million in reserves for
losses and loss expenses, both driven by the increase in net premiums.
The Company, like all users of automated information systems, is addressing
the potential "Year 2000" issues that could affect a wide variety of its
automated information systems, such as mainframe applications, personal
computers, and communications systems. The Company is also addressing the
"Year 2000" issues associated with the information systems utilized by its
suppliers and its independent insurance agents which could have an impact on
the Company. The Company is further addressing risks associated with non-
information systems exposures, such as building security systems and heating
and ventilation.
In 1996, the Company established an internal team dedicated to administering
a "Year 2000" Project. This team completed an initial impact and analysis
study and began to convert or modify its information systems and
applications in 1997. This project is divided into five main areas of
initiative as follows:
1) Infrastructure: an initiative to address hardware and the software
operating systems needed to utilize this hardware. This initiative has been
further divided to examine Mainframe (Enterprise System) and Desktop
workstations (PC and LAN). "Year 2000" upgrades were completed for the
Mainframe portion in early 1998. Inventory of all PC workstations was
completed in August of 1998 and either upgrades or replacement of equipment
is underway and expected to be complete first quarter 1999.
2) Applications: an initiative to address the core software systems, such
as policy underwriting, claims and general ledger, that process daily
business at the Company. A majority of these applications were developed
in-house or customized for the Company's operations. Utilizing non-employee
external programming teams, these systems were converted, unit tested and
replaced in production by January 1998. A series of system integration
tests have been planned to test "Year 2000" readiness. One test was
completed in 1998, test number two is in progress and two additional tests
have been scheduled for 1999. These examinations are intended to
synchronize all such systems, introduce new software which is "Year 2000"
compatible and test whether "Year 2000" bugs were introduced through
routine maintenance. Two new systems, a claim system and general ledger,
are currently being implemented and are expected to be complete in early
1999.
-16-
PAGE
3) Third party review: an initiative to address suppliers and customers.
The Company's suppliers include software vendors, service providers and
material suppliers. Each of the firms in these areas has been contacted by
the Company to obtain written information on the status of their "Year 2000"
readiness, and to date the majority of responses indicate "Year 2000"
readiness. Software upgrades are being unit tested and included in the
integration tests. Contingency plans are being developed as needed for areas
deemed at risk due to software delivery delays or the nature of the service.
A contingency plan has been developed for each area of risk identified to
date. Independent insurance agents are the Company's main business
customers and make up the remaining portion of the "Year 2000" review area.
The Company has provided "Year 2000" information mailings to all agents.
Selective Insurance representatives have spoken at agency functions and a
"Year 2000" hotline was created for questions. The Company continues to look
for opportunities to provide support and advice to our agents.
To ensure that the "Year 2000" awareness campaign has been effective, the
Information Technology Group is currently surveying the independent agency
force to determine the status of their "Year 2000" readiness. Missing
information, regarding the types of hardware and software in the agent's
offices, will be obtained by the Agency Management Specialists, the main
contact between the Company and the agent, as they visit each office. This
information will be evaluated by the Company to develop contingency plans.
4) Insurance Policies: an initiative to address coverage provided to the
Company's insureds. The Company believes that most significant "Year 2000"
insurance claims are likely to occur in the information technology business
sector, and under the error and omissions (E&O) insurance coverages and
directors and officers liability (D&O) insurance coverages. The Company
does not significantly participate in these markets, nor does it
significantly write E&O and D&O coverage types. The Company has communicated
to agents and policyholders that we will not provide coverage for "Year
2000" losses with the possible exception of losses involving property damage
or bodily injury which are otherwise covered which can not be quantified at
this time. The Company plans to use Insurance Services Office ISO
exclusionary endorsements that underscore this on all new and renewal
commercial lines policies.
5) Administration: an initiative to address overall project plans,
methodology, schedule, coordination and miscellaneous items that do not
fit other categories. This initiative also includes creating a "Year 2000"
awareness campaign and responding to inquiries from outside the Company, such
as from independent insurance agents and customers.
The failure to correct a material "Year 2000" problem could result in an
interruption in, or a failure of, certain normal business activities or
operations such as policy underwriting and claim payment. Such failures
could materially and adversely affect the Company's results of operations,
liquidity and financial condition. Due to the general uncertainty inherent
in the "Year 2000" problem, resulting in part from the uncertainty of the
"Year 2000" readiness of independent insurance agents, third-party suppliers
and customers, the Company is unable to determine at this time whether, or
to the
-17-
PAGE
extent to which the consequences of "Year 2000" failures will have a
material impact on the Company's results of operations, liquidity or
financial condition. The Company's "Year 2000" Project is expected to
significantly reduce the Company's level of uncertainty about the "Year
2000" problem and, in particular, about the "Year 2000" readiness within
the Company's internal systems. The Company believes that, with the
progress of the Project to date, and in the event of the completion of the
Project as scheduled, the possibility of significant interruptions of
normal operations will be greatly reduced.
While the Company feels that "Year 2000" exposures will be adequately
addressed before any seriously adverse "Year 2000" situations arise,
contingency plans have been developed for material areas of the Company's
internal information systems including securing disaster recovery sites
provided by outside parties. The Company has secured a first priority status
with the disaster recovery provider by complying with their "Year 2000"
readiness checklist.
The Company does not presently anticipate that costs incurred for the "Year
2000" will be significant or that "Year 2000" issues will have a material
impact on its results of operations or financial condition. The Company's
early start, some systems already in place designed for "Year 2000" and a
centralized mainframe system have helped to reduce the cost of compliance.
Our current estimates of the expenses that will be incurred exclusively to
ensure "Year 2000" readiness will be approximately $1.5 million, of which
approximately $1 million has been spent to date.
-18-
PAGE
Part II
- -------
Item 5. Other Information.
A duly executed proxy given in connection with Selective's 1999
Annual Meeting of Stockholders will confer discretionary authority
on the proxies named therein, or any of them, to vote at such
meeting on any matter of which Selective does not have written
notice on or before February 15, 1999, which is forty-five days
prior to the date on which Selective first mailed its proxy
materials for its 1998 Annual Meeting of Stockholders, without
advice in Selective's proxy statement as to the nature of such
matter.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits:
The exhibits required by Item 601 of Regulation SK are listed in
the Exhibit Index, which immediately precedes the exhibits filed
with this form 10-Q.
(b) Reports on Form 8-K:
There were no reports on Form 8-K filed during the period covered
by this report.
-19-
PAGE
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SELECTIVE INSURANCE GROUP, INC.
Registrant
Date: November 16, 1998
By: /s/Gregory E. Murphy
--------------------------------------
Gregory E. Murphy
President and
Chief Operating Officer
Date: November 16, 1998
By: /s/David B. Merclean
-------------------------------------
David B. Merclean,
Senior Vice President
and Chief Financial Officer
-20-
PAGE
SELECTIVE INSURANCE GROUP, INC.
INDEX TO EXHIBITS
Exhibit No.
11 Statement Re Computation of Per Share Earnings, filed herewith.
27 Financial Data Schedule, filed herewith.
-21-
PAGE
EXHIBIT 11
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
COMPUTATION OF EARNINGS PER SHARE
For the nine-months ended September 30, 1998 and 1997
(in thousands, except per Income Shares Per Share
share amounts) (Numerator) (Denominator) Amount
- ---------------------------------------------------------------------
1998
- ----
Basic EPS
Net Income available
to common stockholders $ 42,498 28,716 $ 1.48
====
Effect of Dilutive Securities
Restricted stock - 532
8.75% convertible
subordinated debentures 346 940
Stock Options (898) 535
------ ------
Diluted EPS
Income available to common
stockholders + assumed
conversions $ 41,946 30,723 $ 1.37
====== ====== ====
- ------------------------------------------------------------------------
1997
- ----
Basic EPS
Net Income available
to common stockholders $ 52,199 28,904 $ 1.81
====
Effect of Dilutive Securities
Restricted stock - 412
8.75% convertible
subordinated debentures 297 972
Stock Options 184 604
------ ------
Diluted EPS
Income available to common
stockholders + assumed
conversions $ 52,680 30,892 $ 1.71
====== ====== ====
-1-
Page
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
COMPUTATION OF EARNINGS PER SHARE
For the quarter ended September 30,1998 and 1997
(in thousands, except per Income Shares Per Share
share amounts) (Numerator) (Denominator) Amount
- ---------------------------------------------------------------------
1998
- ----
Basic EPS
Net Income available
to common stockholders $ 12,932 28,308 $ 0.46
====
Effect of Dilutive Securities
Restricted stock - 550
8.75% convertible
subordinated debentures 149 896
Stock Options (157) 281
------ ------
Diluted EPS
Income available to common
stockholders + assumed
conversions $ 12,924 30,035 $ 0.43
====== ====== ====
- ------------------------------------------------------------------------
1997
- ----
Basic EPS
Net Income available
to common stockholders $ 18,395 28,938 $ 0.64
====
Effect of Dilutive Securities
Restricted stock - 413
8.75% convertible
subordinated debentures 99 971
Stock Options 61 725
------ ------
Diluted EPS
Income available to common
stockholders + assumed
conversions $ 18,555 31,047 $ 0.60
====== ====== ====
-2-
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary financial information extracted from the
September 30, 1998 10Q and is qualified in its entirety by reference to
such financial statements.
</LEGEND>
<CIK> 0000230557
<NAME> SELECTIVE INSURANCE GROUP, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<DEBT-HELD-FOR-SALE> 1,050,907
<DEBT-CARRYING-VALUE> 370,557
<DEBT-MARKET-VALUE> 388,334
<EQUITIES> 236,355
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 1,726,257
<CASH> 9,967
<RECOVER-REINSURE> 10,085
<DEFERRED-ACQUISITION> 115,300
<TOTAL-ASSETS> 2,410,080
<POLICY-LOSSES> 1,184,947<F1>
<UNEARNED-PREMIUMS> 417,668
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 120,766<F2>
0
0
<COMMON> 73,948
<OTHER-SE> 506,834
<TOTAL-LIABILITY-AND-EQUITY> 2,410,080
536,496
<INVESTMENT-INCOME> 72,792
<INVESTMENT-GAINS> 2,788
<OTHER-INCOME> 7,123
<BENEFITS> 381,212<F3>
<UNDERWRITING-AMORTIZATION> 169,583
<UNDERWRITING-OTHER> 0
<INCOME-PRETAX> 52,006
<INCOME-TAX> 9,508
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 42,498
<EPS-PRIMARY> 1.48
<EPS-DILUTED> 1.37
<RESERVE-OPEN> 1,161,169<F4>
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 1,184,947<F5>
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1>Equals the sum of Reserve for losses and the Reserve for loss expenses.
<F2>Equals the sum of Notes payable, Short-term debt, and Convertible
subordinated debentures.
<F3>Equals the sum of losses incurred and loss expenses incurred.
<F4>Equals the sum of Reserve for losses and Reserve for loss expenses
at the beginning of the year.
<F5>Equals the sum of Reserve for losses and Reserve for loss expenses at
the end of the period.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains restated summary financial information extracted
from the September 30, 1997 10Q and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<RESTATED>
<CIK> 0000230557
<NAME> SELECTIVE INSURANCE GROUP, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1997
<DEBT-HELD-FOR-SALE> 1,061,144
<DEBT-CARRYING-VALUE> 409,653
<DEBT-MARKET-VALUE> 424,444
<EQUITIES> 214,312
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 1,714,374
<CASH> 7,413
<RECOVER-REINSURE> 12,176
<DEFERRED-ACQUISITION> 102,504
<TOTAL-ASSETS> 2,328,336
<POLICY-LOSSES> 1,182,605<F1>
<UNEARNED-PREMIUMS> 395,298
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 119,236<F2>
0
0
<COMMON> 72,562
<OTHER-SE> 477,363
<TOTAL-LIABILITY-AND-EQUITY> 2,328,336
509,752
<INVESTMENT-INCOME> 73,605
<INVESTMENT-GAINS> 5,355
<OTHER-INCOME> 3,392
<BENEFITS> 353,577<F3>
<UNDERWRITING-AMORTIZATION> 153,686
<UNDERWRITING-OTHER> 0
<INCOME-PRETAX> 68,111
<INCOME-TAX> 15,912
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 52,199
<EPS-PRIMARY> 1.81
<EPS-DILUTED> 1.71
<RESERVE-OPEN> 1,189,793<F4>
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 1,182,605<F5>
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1>Equals the sum of Reserve for losses and the Reserve for loss expenses.
<F2>Equals the sum of Notes payable, Short-term debt, and Convertible
subordinated debentures.
<F3>Equals the sum of losses incurred and loss expenses incurred.
<F4>Equals the sum of Reserve for losses and Reserve for loss expenses
at the beginning of the year.
<F5>Equals the sum of Reserve for losses and Reserve for loss expenses at
the end of the period.
</FN>
</TABLE>
